Profit Margin Waterfall
Where every pound of revenue actually goes.
“Revenue is a vanity number. The real story is the waterfall — where every pound came in, and which pounds leaked away before they reached the bottom.”
The Insight
The waterfall diagnoses a business in ten seconds. It shows you exactly which line is eating your profitability, and how much of your growth is secretly going to service cost rather than owner return. Founders who don't know their waterfall are flying blind.
01
Revenue → Gross Profit
Top line: £1.00 of revenue. Subtract cost of goods (for services: delivery labour, tools, directly allocated overheads). What's left is gross profit — typically 40–70% for services, 60–85% for SaaS, 30–50% for product. If your gross margin is below SMB norm for your category, everything downstream is a fight. Fix gross first; nothing else works until it does.
02
Gross Profit → Operating Income
Subtract sales and marketing, R&D, and general admin. What's left is operating income — the true measure of whether the business pays for itself. SMB healthy operating margin is 15–25%; below 10% and you're working for free; above 30% and you may be under-investing in growth. The waterfall makes this visible: you see exactly which function consumes how much, and can challenge any line that feels oversized.
03
Operating Income → Owner Earnings
Subtract interest, taxes, and (for owner-managed businesses) reinvestment or debt service. What remains is what the business actually generates for the owner each year — dividendable, distributable, real. Most SMB owners never compute this honestly and are shocked when they do. The waterfall ends in a number. That number is what the business is actually for.
The Takeaway
Draw your waterfall. Label every line. Review quarterly. Growth without waterfall discipline is just a bigger version of whatever leaks were already there.
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